Our study finds the largest one-year decline in fund fees

Patty Oey, Morningstar Research Services LLC

Morningstar Research Services LLC (herein referred to as
"Morningstar") publishes an annual study on fund fees that examines the
trends in fees across U.S. open-end mutual funds and exchange-traded funds.

Last year, investors paid an average 0.52% expense for funds, as
measured by the asset-weighted average expense ratio of roughly 25,000
U.S. open-end mutual funds and ETFs. This marked an 8% decline from
2016, which is the largest year-over-year decline that we've recorded
since we began tracking this data in 2000.

We estimate this 8% decline translated into a $4 billion savings to
investors in 2017. This fee decline is a big positive for most
investors, because fees compound over time and can diminish returns.

How we examined fund fees

By using an asset-weighted average, we give more weight to funds
most widely held by investors, using asset size as a proxy, to reflect
the average fees paid by investors. This figure is a more realistic
average, relative to an equal-weighted average.

For example, for U.S. equity funds, the asset-weighted average
expense ratio was 0.45% versus the equal-weighted average expense
ratio of 1.10%. Funds with expense ratios above 1.10% only accounted
for less than 10% of asset invested in US equity funds in 2017, so the
simple average does not reflect most investors’ experience.

Investors’ shift to passive funds is pushing down fund fees

Over the last few years, one of the main drivers of falling
asset-weighted average fees has been flows into lower-cost funds,
primarily the migration from active to passive for U.S.
equities exposure.

Also contributing to declines have been aggressive fee cuts for
passively managed, core U.S. equity, taxable bond, and international
equity index funds, which in turn have drawn strong inflows. On the
active side, instead of fee cuts, many fund companies have been more
likely to introduce lower cost share classes.

While most passive funds are already significantly cheaper than
their active peers, asset-weighted average fees continue to decline at
a faster clip for the former group, as shown below.

Cost counts: Flows into cheaper funds have soared

The flows into cheaper share classes has been rising steadily since
2000. But in the last five years, the difference in flows for cheap
share classes versus more expensive share classes has accelerated rapidly.

In 2017, funds with a Morningstar Fee Level — Broad rank of Low
(fees ranked in the bottom quintile, or 20%, among funds within their
category group); saw net inflows of $949 billion, the highest ever,
and a 60% increase over 2016 levels. In 2017, passively managed funds
accounted for 70% of the net flows into Low-fee-ranked funds, while
actively managed funds accounted for the remaining 30%.

Flows out of funds with Below Average, Average, Above Average, and
High ranked fees (the remaining 80%) have been ongoing since 2014 and
reached $251 billion in 2017, a decline from 2016’s $414 billion, but
higher than 2014 and 2015 levels of $66 billion and $212 billion, respectively.

As a result of these trends, most investors are in lower-priced
funds. Currently, 83% of all assets are in open-end mutual funds and
ETFs that have a Low or Below Average Morningstar Fee Level — Broad
rank (fees within the bottom two quintiles), 11% are in funds with an
Average rank, and 6% are in funds with an Above Average or High rank.

What might the future hold for fund fees? We’ll be watching

Morningstar research has demonstrated that mutual fund fees can
sometimes be a reliable predictor of future returns, as lower-cost
mutual funds generally outperform their more-expensive peers. This
trend of falling costs for investors is certainly positive--and we’ll
continue to monitor it.

Read the full version of our latest U.S. fund
fee study.

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